The Federal Reserve of the United States of America obliges any Bank of America to form a certain amount of cash reserves. They are needed for operations with customers. This is necessary in case most of the customers immediately want to withdraw all their deposits. In this case, the banking institution may not have enough finance, and then, most likely, another banking crisis will occur. It is because of this that the Fed establishes a certain framework for the size of required reserves, the size of which is affected by the Fed rate.
What is the Federal Reserve discount rate
Every day, banks carry out a huge number of operations, and each of them tries to increase their volume for the growth of recoverable profit. Sometimes clients come and withdraw a large amount of money without warning, as a result of which the level of required reserves of a financial institution decreases and ceases to comply with the Fed's instructions. This will cause a lot of problems for the bank in the future.
The Fed interest rate is the rate at which the Central Bank of America issues loans to American banks. Due to these loans, financial institutions increase the level of reserves in order to meet the requirements of the Fed.
In most cases, banks lend to each other, but if banks do not have the opportunity to help their “colleague,” the latter turns to the Fed. This credit under the law must be repaid the next day. The Fed is negative about such loans. If they are also becoming more frequent, the Fed has the right to tighten requirements for mandatory reserves.
What is the interest rate for?
Its need is as follows: it acts as the basis for calculating other rates in the state. Along with this, the Fed loans are low-risk loans, because they are issued only for one night and only to banking institutions with excellent credit history.
If we consider the stock markets, an increase in rates is an increase in the cost of capital of the organization. That is, for enterprises whose shares are traded on the stock exchange, this is a negative point. For bonds it is different - raising the rate leads to lower inflation.
The currency market is a little more complicated, here the Fed rate affects the exchange rate from several sides. Of course, there is a course, all transactions with currencies follow. But this is only a small fraction of the scheme. The financial flows of the world, which are responsible for most of the transactions conducted in the world on the currency market, are the movement of capital, which is caused by the desire of investors to find a large profit from investments. Taking into account the situation of all types of markets, including the housing market and inflation data, in any state, an increase in the discount rate has both a positive and negative impact on profitability.
Prior to this, the Fed rate increased on June 29, 2006. For 2007-2008 The Federal Reserve slowly lowered it until the moment when it did not approach the smallest indicator of 0-0.25% in the winter of 2008.
Fed rate hike
What this action will lead to is discussed below. The labor market indicators in small and medium-sized businesses in America today are the highest, and the unemployment rate has halved compared to 2009. The Fed believes that the recovery of the labor market has every chance to spur inflation and increase wages, thereby supporting the state’s economy.
In 2007-2009 in the United States there has been a crisis in the housing market and in the banking sector. The Fed then was able to keep the state economy from becoming depressed.
Can the US economy survive the Fed rate hike today? Analysts here make various assumptions. Some argue that the Fed was able to smoothly keep the state’s economic position afloat. And then raising the Fed rate by 0.25 points will have a minimal impact on the US economy. Others point to a very low inflation rate, arguing that by doing so, the Fed could bring down global markets and create the preconditions for the dollar to rise if the Fed hurries with a decision.
The chairman of the Federal Reserve says the rate hike is planned to be smooth. Experts in this field believe that the growth rate will be lower, comparing with the time of the last session, which was started in 2004. The total indicator of the discount rate will not exceed 3%.
Are everyone ready for change? Some corporations used low-rate time to arrange loans through the bond market. And now they say that they see no reason for concern in the small rate increase, believing that the market has already been able to use all the opportunities. At the same time, a large number of organizations that hold only at the expense of low rates will not be able to resist their growth, and thereby they will have problems after an increase in loan costs.
Paying attention to investors, most experts believe that the Fed warned them in advance about their intentions, and traders probably already took into account future growth in strategies. But some experts are sure that there will still be volatility from such serious adjustments in monetary policy, given that for seven years the indicator was zero.
Below we consider how the Fed discount rate can affect global markets.
Discount rate and its impact on the economy of England
Most economists believe that the British Bank, following the American Central Bank, will go on raising rates. History has repeatedly seen how the discount rates of the United States and England were adjusted simultaneously.
Today, the growth of the economy of Misty Albion is stable, the demand for labor is high. The head of the Bank of England emphasized that perhaps growth will become smooth.
Discount rate and its impact on Russia
The Central Bank of the Russian Federation will not be able to avoid negative influences from the strengthening of the American currency and the growth of the discount rate. This fact will entail problems with the buildup of international reserves, reduced to $ 365 billion from over $ 500 billion.
Experts believe that, of course, the increase in rates will adversely affect the economy of our state. But this influence will not be so strong compared to other emerging markets., Since, due to the sanctions of the Russian Federation, it is no longer so economically connected with the United States.
Discount rate and its impact on Europe
An increase in the discount rate may adversely affect the economic situation of the EU states; this may cause an increase in the volatility and unpredictability of the market.
The head of the European Central Bank and other politicians believe that the recent wave of volatility in world markets will have a strong negative effect on the revival of the European economy.
Discount rate and its impact on China
In response to the question of what will happen if the Fed raises rates, the Chinese authorities believe that they will be able to avoid a direct impact on the state’s economy from rising rates, and the impact will be small.
The rate of the Federal Reserve in a limited range affects the economy of China. A negative impact on the economy of the state is exerted by internal factors, for example, a drop in the competitiveness of products manufactured for export and overproduction.
Discount rate and its impact on Japan
Inflation here is also almost at zero level. Therefore, if the Federal Reserve refuses to tighten policies, sooner or later there will still be a significant difference between the rates of the United States and Japan.
According to some experts, raising the Fed rate will make owning the American currency more attractive. But along with this, the weakening of the Japanese currency will negatively affect the share of profits of importers and increase the share of profits of large exporters.
At what stage is the market now
The essence of such a step as raising the interest rate of the Fed is to circumvent the emergence of market “bubbles” that are caused by the very soft monetary policy of the Fed, which has been carried out for a long time.
To assess the current situation, it is better to conduct a retrospective analysis. Here it is important to note that the identification of the stages of the economy is a very subjective moment. Probably, 2016 will be in the middle of the economic cycle.
Experts, however, do not expect sharp movements from the Fed. But there is a danger in the rather late or significantly slower movement of such a step as raising the Fed rate, which can lead to a rapid increase in inflation and faster growth of the Fed key rates , which will negatively affect the stock market.
The conclusion to the discussion about what the Fed’s rate hike will lead to can be formulated as follows: until the Federal Reserve announces an increase in interest rates, it is better to get rid of the shares of American companies. After rates begin to rise, you can wait for the correction of the market and re-acquire American assets.